Reflections on Property Investing

Reflections on Property Investing

Reflections on Property Investing


People often say that successful property investment is about “location, location, location”.  

But after 30 years, working across 10 major markets for at least a year or more, I have a different view. 

In my experience, successful property investors exhibit five qualities continuously:

    1. Adapt to Macro Events
    2. Anticipate Government Policy
    3. Demand Above-Market Returns
    4. Think Like a Contrarian
    5. Understand Supply-Demand Dynamics

While these are inter-related, for the purposes of this note I’ll treat them as standalone.

(1) Adapt to Macro Events

A great real estate investor who mentored me for many years was also a world-class surfer.

And from his surfing days he picked up a truism which is blindingly obvious:

“For the surfer, it doesn’t matter how hard you paddle, it’s all about the wave.”

Think about the surfer as an investor; and the paddling as desk-top analysis; and the wave as the market.

What becomes clear is that, perhaps unfairly, no matter how hard you work to analyse a market, you are always at the mercy of it.

Who could have predicted the Covid-19 pandemic?  Or the SARS epidemic 20 years earlier?  Or the emergence of climate change as a non-negotiable issue?  

Like the surfer, the smart investor works on their analytic “muscle” to paddle the board and position themselves to catch the wave.  But they never measure themselves by how good they are at paddling; rather, they succeed or fail based on their ability to catch and ride the wave.

Taking this analogy one step further, the best financial returns almost always occur following a “monster wave”.  

At such moments, many surfers are either already on the beach, or too timid to go back in the water.

But those who do catch the wave – due to skill, foresight, courage, luck, or a combination of these – often experience the ride of their lives.

For example, investors who bought Asian hotels after the SARS epidemic in the early 2000s made 20%+ annual returns for three years following the crash, as markets rebounded.  (I know, I was one of them).

Similarly, the fleet of foot who bought REIT stocks in 2009 after the Global Financial Crisis, or retail stocks after the Covid pandemic, outperformed long-term benchmarks. (I was also one of these).

The moral of the story is this:  look up from your spreadsheet, observe what is going on around you, read everything you can, and talk to smart people. 

In short, try to anticipate the wave.

(2) Anticipate Government Policy

I was a child of globalisation, born in 1964, the last year of the baby boom.

The period from the late 1980s through to the GFC in 2008 was one of extraordinary opportunity: a safe, “unipolar” world, led by the United States, reinforced by the European Union, aided by the opening of China, nations everywhere focused on eliminating trade barriers, integrating global supply chains, and allowing the free movement of people and goods.

The rock band REM even wrote a song about it, the classic Daysleeper.

These were heady days for young, freshly minted Harvard MBAs like me.

But then the GFC hit in 2008, and everything changed.  

Our first real economic hardship in over 20 years came as a shock.  And in the decade that followed, major markets such as the US and the UK experienced political upheavals (think Brexit, think Trump) which were unimaginable a few years previously.

These disruptions, and the sense that “the system” had failed to protect ordinary people, had major implications for the role of government.

In short, governments became much more active, and their populist response impacted property markets enormously.

The most obvious example was the global coordination of low interest rates by central banks, which helped governments of all persuasions shore up votes in the mortgage belt, in the process driving, at minimum, a doubling of residential property values in most major markets.

With the advent of Covid-19, our Australian government enacted policies which further stimulated the residential market and led to a retail sales boom.  

Defying common sense, we had twin booms in residential and retail sales, in the middle of a pandemic.

None of this commentary involves a value judgment.  

These policies were humanistic, well-intentioned, and no doubt cushioned the blow for many in our community. 

But none of these represented the free-market principles which many of my generation, perhaps arrogantly, had come to expect as a birthright.

The implication for the astute investor is they can no longer assume away government policy and focus purely on “the market”.

The decision of where and when to invest today requires anticipation of future policy shifts.

Government is back in our lives, in a big way.

The smart investor will acknowledge this new reality, rather than be nostalgic for a bygone era.

Which is a memo to myself.

Listen to Grant Kelley on The Big Deal podcast with Warren Tredrea here

(3) Demand Above-Market Returns

Unlike most real estate investors, who are trained in property appraisals, or make their way as a developer, or climb a corporate ladder, I came to property investing laterally, from a financial background.  (And not even property finance at that, but private equity).

Perhaps as a result, I am sometimes criticised for focusing excessively on the financial aspects of property investing.  

“You’ve got to understand the dirt” or “this building has great bones” are phrases which still haunt me.

But I freely admit to my supposed bias.  To state the obvious, financial returns should ultimately drive investment decision-making.

From this (albeit biased) starting point, I developed a clear view of the importance of government bond yields for differentiating good versus bad deals.

The logic is simple: government bonds are risk-free, representing the base return which investors should expect for their money.

By contrast, real estate investing is never risk-free.  In fact, depending on the asset class, real estate cycles are remarkably volatile.  And incredibly illiquid, especially when markets turn against you.

It follows that, depending on the “risk” of the asset class – and specifically, yield-based, typically non-residential assets – investors should seek a premium to prevailing government bond yields in the market where the asset is located, matched to the period that they expect to hold the asset.

The premia I have often used to generate an acceptable, risk-adjusted return by asset class are:

    • Commercial property: +200 basis points
    • Retail: + 200 to +300 basis points
    • Hospitality +300 to +400 basis points.

To reiterate, because government bond yields vary according to their maturity (two years, five years, 10 years etc), these premia should be calculated by reference  to how long the investor intends to hold the property.

If all else fails, I default to the 10-year yield, as 10 years provides a reasonable, middle-of-the-road hold period.

Some will argue that it this approach is too crude, insufficiently factoring in the growth of the asset or its asset class, the specifics of the property itself (e.g., does it have developable land?), etc.  All of which are factors to consider as well.

But the comparison to bond yields is a great way to avoid a bad decision.

The following story illustrates my point.  

Some years ago, a highly esteemed developer offered me the “opportunity” to buy a trophy office building in downtown Tokyo at a 1.75% yield.

A quick look at Bloomberg showed me that the Japanese 10-year bond was trading at a 2.25% yield at that exact moment.  A deeper dive showed that the last time Tokyo’s commercial property market had traded at a premium to the risk-free rate was in the mid-1980s, just prior to its spectacular crash.

The sales pitch from the seller to me was effectively: “Invest at a 50-basis point premium to the risk-free rate, in an illiquid asset”.  

I politely declined, explaining my logic as follows: “If I spend my money on a bond, I can get a 0.5% better return, and if I change my mind, I can sell it half-an-hour later and head to the golf course”.  

And there are a lot of great golf courses in Japan.

The postscript to the story: a competitor bought the asset and was forced to wind up his fund two years later, the developer offered me a job, and I reduced my golf handicap.

(4) Think Like a Contrarian

The property industry, particularly at the “institutional level”, is very clubby.

If you doubt this, go to a property conference, and watch the backslapping at the 5PM “Happy Hour”.

A lot of “groupthink” going on, and not much challenge to the status quo.

But to out-perform any market, it is first necessary to challenge the orthodoxy of that market.  

Contrarian thinking is not easy. By its nature it means pushing outside your comfort zone.

I am an Australian who lived in Asia for 20 years.  I was well-regarded for my ability to work across markets, cultures, and language barriers.  And yet, for a long time, I found the capital flows emanating from Asia difficult to grasp fully.

For example, buying an expensive apartment for your kid in an Australian city because you prized your child’s education above all else was at first an alien concept to me (although one I found deeply admirable).  

As such I underestimated the depth of the “for sale” market for Australian student accommodation to foreign students and their families.

But, as a Singapore-based CEO, I quickly adapted and marketed a residential project in Brisbane to Asian-based investors around precisely this concept.  

Prior to this, sales had stalled under an original marketing plan which focused on Australian retirees.  By thinking outside the box, we sold our development off-plan within three months.

The moral of the story is: constantly challenge your own implicit and explicit assumptions. Meet the unmet need.  Be unconstrained to the extent you can.  

The additional lesson is that identifying a motivated “pocket” of cash, which wants to buy, is always – repeat, always — more important than the orthodox “fundamentals”.

(5) Understand Supply-Demand Dynamics

In professional sport, it is often said that you can’t “out run” a bad diet.

Similarly, none of my first four points matter if a market has excess supply, or demand is going nuts.

Put simply, you can’t “out invest” a bad market.

When supply is at excess, buy.  When demand is at excess, sell.

Stay unemotional.

Pretty simple really.

And most of the time I’ve stuck to this maxim.

Approaching the GFC, I had an inkling that markets were overheating.  And so, in early 2007, I literally sold 90% of my portfolio, and sat out the remainder of the boom, which ran for another 12 months.  

I was for a while (and not for the first time) highly unfashionable.

And I had to part ways with some truly beautiful assets, including a baseball stadium in Japan, where I loved going to games and eating sushi in-between innings.

But in 2008, I was proven correct. 

Subsequently, by the early 2010s, it was clear we were through the worst of it.

So, I started buying again.

A 4,000-acre sheep farm in Australia was probably my best investment.

Being from a winemaking background I knew nothing about sheep.  

But I knew that Chinese and Indian demand was going through the roof, with consumers wanting high-quality protein, from Australian farms, as their incomes grew.  

At a buy-in price of 3,000 dollars per acre, I couldn’t go too far wrong in the face of such booming demand.  Even though in reality I knew nothing about the underlying business.

Five years later I sold the asset for just under 7,000 dollars per acre.

The moral of the story is that supply and demand have their own logic.  Be it right or wrong, this logic is unchallengeable. It just is.  

As they say on Wall Street, you can’t “fight the tape”.  

Make obvious choices, stay unemotional, buy when it’s time, and sell when time’s up.

Read the first GK Insight here – The Parallels Between Business and Sport

Leave a Reply